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by Dr. Khalid Zaheer Posted 13 July 2007
One of the most obvious reasons why modern banking is
condemned conflicting with the Islamic teachings is ³the
unequivocal prohibition of riba by Quran, which the consensus
of Muslim jurists has interpreted as covering all kinds of
interest« ³(Siddiqi 1983,9). The income of most of the banks
comes predominantly from the difference between the interest
they charge on loans to their borrowers and what they pay to
their depositors.
The Quran prohibits interest primarily because it is unfair. In
this article we will take up some of the more important questions
concerning the nature of interest to show that the interest
charged by the banks is very much within the scope of riba
which has been prohibited in Islam.

 
As regards the definition of riba, Ahmad (S.M.) has rightly
pointed out that if while reading Quran ï
 



 
 (2:279) is read with zaroo ma baqiya min al-
riba [sic] (2:278) we easily reach the definition of riba [sic]. Any
excess above the borrowed sum [charged by the lender] is
interest´ (Ahmad, S.M 1989, 43). Abu Bakar Al-Jassas has
defined riba-based arrangement thus: it is loan given for a
certain duration with the condition of an increased obligation on
the borrower [compared to the principal borrowed] (Al-Jassas
n.d. Vol. 1,469).
The clarification offered by Pakistan¶s Federal Shariah Court¶s
Judgement on Riba is quite unequivocal It also states that it
makes no difference whether the loan is for consumption
purposes or for commercial purposes. Similarly, it does not
matter if the rate of interest is low or high, simple or compound,
for short or¶ long term, between two Muslims or between a
Muslim and a non-Muslim or between a citizen and a state or
between two states. Any excess which is pre-determined over
the principal sum in a loan transaction will constitute riba all
circumstances.
The above verdict is not the first of its kind to be presented by a
group of Muslim legal experts on the subject in recent times.
More than a quarter of a century ago in the Second Annual
Conference of the College of¶ Islamic Research in Cairo it was
declared that ³interest charged on the various kinds of loans
constitutes unlawful usury, regardless of whether the loan is for
what is called consumption or production [purposes]. ´It also
affirmed that ³much and little usury is unlawful´. Although ii
has not been explicitly clarified in the above statement, the
definition does seem to imply that in Islam riba does not
recognize any distinction between interest agreed by the pasties
and interest charged for de1ay in payment as penalty, as the laws
of present-day states likes, for instance, Egypt and France do.
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Many modern writers tend to confuse interest with rent because
of the apparent similarity in the two arrangements of carrying a
fixed charge. The distinction between the two, though, is quite
clear. Whereas interest, in the context of the Islamic teachings.
is the fixed return demanded from another party on borrowing
something which by nature is such that It is exhausted when it is
put to use, rent is associated with those assets which remain, by
and large, intact while they are in the process of being used.
Interest has been prohibited because, once exhausted, the
remaking of the borrowed article itself is not guaranteed. The
only fair way to lend such articles, therefore, is to do so on a
sharing agreement for business purposes and an interest-free
basis on loans for personal needs)¶ In the case of rental
agreements, since nothing normally happens to the asset
borrowed, the borrower is not likely to be in serious trouble like
his counterpart hi the interest-based arrangements and should,
therefore, have no difficulty in paying the fixed charge. In a cue
where something happens to the asset that destroy it completely
or partially, it is the sole responsibility of the owner, unless it is
proved flit the user damaged the asset deliberately or was guilty
of willful neglect in protecting It. Indeed, the lender of Interest-
based loans also undertakes the default risk, yet that risk is only
in the event that the borrower disappears or somehow proves
that he is unable to pay back the loan even from his personal
wealth. Under normal circumstances the lender is able to recover
his fixed charge from the borrower. Moreover, what is more
important is the fact that the lender does not intend to forego his
interest even in the case where the borrower loses the principal
amount as well. The fact that the latter sometimes gets Say
without paying interest or even the principal amount is not
because of a kind-heisted disposition on the part of the lender,
but rather in spite Of his firm resolve. In short, the only reason
why Qur¶an has prohibited interest is that the chargers of interest
disregard the plight of the borrowers and not necessarily because
they do not undertake any risk at all It is therefore, not quite
correct to state that in Islam the ³general principle which is
beyond dispute as being the criterion for determining the
permissibility or otherwise of any method of financing a that the
financier cannot avert the taking of some risk if he wishes to
derive an income´ (Chapra 1985, 166).
Keynes made a distinction between interest charged on capital
and the rent on land by suggesting that while there could be
intrinsic reasons for scarcity of land, there west none in the case
of capital, at teat in the long run. (Keynes 1973, 376) Indeed,
there are reasons for criticism on charging interest from a purely
economic point of view as well; however, the basic reason. Why
it has been condemned by Islam is moral, i.e. interest exploits
the need of individuals and stems from greedy and selfish
motives of the owners of capital in complete disregard of
benevolence, justice, and fairy play. Rent, under normal
circumstances, if it is not unfairly exorbitant, cannot be
subjected to the same criticism.
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There are writers who believe that only that type of interest
which is charged by rich money-lender on consumption loans to
the poor is prohibited by Qurãn. The Advisory Council of
Islamic Ideology of Pakistan too in its meeting on January 33,
1964 at Karachi decided ³that µRiba¶ is forbidden but [the
Council] is in disagreement as to whether µInterest in the form in
which it appears in public transactions¶ which in the opinion of
Council includes µinstitutional credit¶ as well would also be
covered by µRiba¶ specified in the Holy Quran...´ There are
others who believe that there, was no direct evidence in the
original teachings of Islam refuting that claim (Khan, W.M.
1985. 27).
There have been attempts to refute such claims and misgivings
on the basis of Qur¶an which, after declaring all interest-based
borrowing and lending unlawful says ³if a debtor is in want,
give him time until his circumstances improve (Qur¶an 2:280). It
has been argued that Qur¶an has, in this verse, directly refuted
all such claims by mentioning that during the time of its
revelation not all the borrowers were needy, otherwise the
conditional statement ³if a debtor is in want´ would have
appeared meaningless. Thus it is concluded that in those times
too interest-based loans were taken out for commercial purposes
as well and that interest is prohibited by Qur¶an, whatever the
purpose (lslahi, Amin A. 1976, 594-5) Islahi goes on to argue
further from the wordings of Quran that in those days too most
of the loans were needed for commercial purposes (ibid.). He
has also quoted Hamiduddin Farahi¶s (1863-1930) opinion about
this verse. He quotes him thus:
It is quits evident from the wording of this verse [i.e. Qur¶an
2:280] that the Arabs used to charge interest from the well-to-do
as well. The people of Quraish, moreover, were traders and
commercial interest was common amongst them. I, therefore,
find not much of a difference between their conditions sad ours
concerning interest and God knows, the truth (Ibid., 595).
The argument (mm Quran alone, however, does not appear to be
as irrefutable as it has been made to look. In the absence of
supportive historical evidence the verse cannot b claimed to be
offering conclusive evidence to the effect that the borrowers at
the time of revelation of Qur¶an ware mostly well-to-do people
who, ipso facto, ought to have borrowed for commercial
purposes. What has been ignored in the argument is that the text
is testifying to the fact that few borrowers were ³in want´ at the
time of revelation of the relevant verses prohibiting and not
necessarily at the time of borrowing. After all, is it not possible
that the people who sit deprived at the time of borrowing remain
no more deprived when the loans mature? Although It is not
very likely that such a change of fortune can take place on a
mass scale under normal circumstances, to assume that all
borrowers were definitely well-to-do traders at that time is no
more than a theoretical possibility, which makes the argument
less than thoroughly convincing. However, there is enough
historical evidence to show that the Arabs used to borrow funds
purely for commercial purposes in the pro-Islamic period.
Mecca, Taif, and Najran were well known commercial centres.
In the absence of agriculture and industry, trading was the only
source of earning and capitalists used to give loans on interest to
merchants and entrepreneurs. Udovitch has firmly stated that
³Any assertion that medieval credit was for consumption only
and not for production is just untenable with reference to the
medieval Near East³ (Udovitch 1970, 86). In the above
mentioned quotation, Farahi has also supported his argument
from Quran by presenting historical reference as well.
_
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There are again other writers -- like, for instance, Fazlur
Rahman -- who think that only excessive compound interest is
prohibited by Quran, and not the moderate, simple one.
Presumably µbased on a similar opinion, interest exceeding 8
percent was prohibits in Egypt, prior to the introduction of the
Civil Code of 1949. On the introduction of the code which was
drafted under the supervision of µAbdar-Razzaq as-Sanhuri,
some changes were introduced to the earlier law. One of the
changes stipulated that interest on Interest was prohibited,
Another stipulation of the act was that the totality of interest due
should not be superior to the principal (Mallat 1988, 75-6). This
latter stipulation seems to have had at least the qualified backing
of Abu Zahrah (1898-1974), a prominent jurist from. the famous
Islamic university of Azhar, Although he pleads that the bank;
should operate on the principle of participation in the profits and
losses (Abu Zahrah n.d., 57), he also offered his opinion about
the stipulation referred to above thus: ³The modern Civil Code
of Egypt has established this Qur¶anic principle (which prohibits
charging of exploitative interest rates] and decided that [the
totality] of interests cannot exceed the principal´ (ibid., 56).
The opinion of most of the writers who are in agreement, with
the above views stems to be based on a verse of Qur¶an which
says: ³O you who believe, do not take riba charging [it] doubled
and redoubled´ (Qur¶an, 3:1 30). They conclude that since
Qur¶an has condemned charging of compound interest in this
verse, all other vents too should be understood in the tight of this
clarification.
This conclusion, however, is as unacceptable as if one were to
conclude from the Qur¶anic verse ³Do not kill your children out
of fear of poverty¶ (Qur¶an, 17:3)) that killing one¶s children for
reasons other than fear of poverty is legitimate according to
Qur¶ân. The two verses, far from bearing the meaning given by
the two above-mentioned interpretations, are suggesting that
whereas charging interest and killing one¶s children are criminal
acts in any case, they are even more detestable if they are
committed ³doubled and redoubled´ and ³out of fear of poverty´
respectively. These additional phrases in the text are meant to
expose the extremely callous nature of the crimes rather than to
provide essential qualifying expressions to define the crimes
themselves.
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It has been explained above that Sunnah of the prophet has
emphasized that in case of transactions involving credit, whether
in the case of sale or financial debt, it is highly important that
the returned article be absolutely identical to the one borrowed
otherwise there is a danger of interest being involved in the
exchange. This principle leads U5 to the question of return of
financial loans in the inflationary or deflationary periods when
the value of. the amount returned undergoes either depreciation
or appreciation compared to what it was when borrowed.
Obviously, if at the time of return of loan, for instance, the real
value of the amount returned has eroded, then clearly the intent
of the teaching of sunnsh is being violated. After all, money
today has no intrinsic value of its own other than what it can buy
(Ranlett. op. cit., 5). If the hundred pounds lent in 1991 by a
person to another could buy x grams of gold and in 1992 when
the amount was returned, it could buy y grams of gold (and x
end y are unequal), clearly it would be a violation of the
condition laid down in the hadith that ³If you lend gold then
receive back the same gold: the same weight and the same
quality ...³ (Muslim. op. cit., Vol 4, 211). It also shows that
giving interest to a lender in a period of high inflation at a rate
less than the inflation rate, which is called negative rate of
interest, is also unfair for the lender and, therefore, should be
avoided. In other words, the prohibition of riba applies to real
interest, not nominal interest, as with inflation a ban on the latter
may result in negative real interest (Baldwin and Wilson 1988,
73). Moreover, in the case of deflation there is a possibility of
positive real interest as well, even in the case a borrower is
returning only the principal amount of¶ the loan. Even though
falling prices are practically seldom experienced, their
occurrence is not impossible, as was experienced in the great
depression of the 1930s.
The solution to the problem lies in indexing the loans with the
price level of a basket of commodities, so that as the loan is
returned it is the value of the amount borrowed which is paid
back and not the face value of the currency which has nothing
similar to what was lent except the meaningless figure of the
loan expressed in a certain currency. The solution of indexation,
however, is not acceptable to many present-day Muslim
economists.
One reason presented against indexation is that such an
arrangement would be µsimilar to interest [such] that it would be
impossible to tell one from the other´.´ I have already submitted
that, contrary to the above claim, it is the very spirit of avoiding
interest which compels one to suggest the solution of indexation.
A somewhat similar stand was. earlier taken by the Council of
Islamic Ideology (CII) or Pakistan against indexation whereby it
was argued that it is a requirement of the shariah that the
borrower should return to the lender the same quantity as
borrowed, even though the price of the commodity may have
changed.7~ That is, however, precisely the principle I am
invoking, although to bring home just the opposite conclusion.
Indeed, if money is to be accepted as a commodity with its own
intrinsic value then the council¶s view would have been correct.
But if that is not the case -- and indeed modern-day money is not
desired for its own sake but for the sake of the commodities it
can fetch´ ‡- then it can be safely concluded that the council has
incorrectly concluded from a correct principle just the opposite
of what it requires.
The second argument against the idea presented is that since
inflation is the result of circumstances beyond the control of the
borrower hence he cannot be held responsible for loss of
purchasing power to the lender (Siddiqi 1992, 407). In response
to that it could be argued that the erosion in value of the loans
has not been caused by the either, so why should he suffer? In
fact, the spirit of justice of the economic teachings of Nan
demands that neither of the panics should suffer unreasonably.
Interestingly, only a few lines later the author shows a complete
reversal of opinion thus: ³The extreme case in which very high
rate of inflation renders a currency almost worthless is however,
a case apart. In such cases it can be considered that now the
worthless currency is a money different from the one in µwhich
the loan was contracted. A formula establishing the µrate of
exchange¶ between the µnew¶ and old currency can be devised
and all earlier loans converted to the µnew currency accordingly´
(ibid., 408). it is difficult to appreciate how a principle which
under normal circumstances is rejected because it is seems to be
unfair to the borrowers can be argued to be acceptable in
extreme cases? Either the principle is fair or unfair. How can it
be fair under one Set of circumstances and unfair under others?
Moreover, who is going to decide if the inflation rate has gone
high enough to be declared extreme?
A thin criticism on the idea of indention is that it ³gives a
privileged position to capital as compared to other factors of
production which are also affected by inflation in one way or the
other.´ It certainly seems to be a valid criticism if the proposal
confines the application of indexation to loans alone. We have
seen in this chapter that (he economic teachings of Islam
emphasize, more than anything else; implementation of justice
in all areas of economic dealings. It is in that very spirit that the
case of indexation of loans: is being pleaded. How is it possible
that the proposal can overlook the equally unfair treatment of
wages, salaries, and other contracts which arc confronted with
similar difficulties due to inflation? Instead of arguing against
the idea of indexation of loans, it should be urged that all other
areas of payment affected by inflation should be covered by the
proposal as well. One way of going about it in the case of wages
and salaries is to ensure that alt public and private sector
organizations should increase wages and salaries of, their
employees every year at least by the percentage of inflation of
that particular year.
A fourth criticism raised against indexation is that when the risk-
taking investors are not assured of a stable real value of their
investments, there appears no reason for savers and cash holders
to be assured when they do not even take any risk (Chapra, op.
cit., 40). The logic behind this criticism is that since risk-taken
are not immune from losses, why should those who choose to
avoid risk be saved against erosion in the value of their money?
The obvious answer lies within the statement of this question:
Since risk shirkers choose not to participate in the profits of
business ventures, they have a right to get back exactly what
they have lent and the risk-taking investors should face losses in
difficult periods because in good periods they also take profits
and, moreover, that is the principle they have chosen their
capital to be dealt with in the real world the profit margins do
normally take into consideration the risk element attributable to
inflation involved in the investment. The same author admits a
couple of pages earlier that Inflation undoubtedly does injustice
to the interest-free lender by eroding the real value of his loan
(ibid., 38). When it comes to the solution of the problem,
however, he chooses to oppose the only workable remedy.
A fifth objection to the idea of indexation is that sometimes
borrowers are unable to earn enough to return the real value of
the principal to their lenders. In that case, it would be unfair to
require the indexed-value of the loans to be returned (Khan,
A.J., op. cit.). However, this objection can also be raised against
the condition of returning the nominal value of a loan if the
borrower has been unable to earn enough to do so. In fact, as
mentioned elsewhere, Quraan urges the believer to forego the
condition o demanding the principal amount as well if the
borrower is in difficulty. Doing so, however, would be an
optional act of benevolence on the part of the lender in
exceptional cases. Under normal circumstances, a borrower is
bound to return to his lender the principal amount. What¶ is
being argued here is that the principal amount which the
borrower is obliged to return is the real value of the loan taken
and not its nominal value.
The justification of indexation can also be viewed from the point
of view of¶ credit sales. Whereas pre-determined higher prices
for; credit sates is undoubtedly riba if the deferred prices of
commodities are forced to remain equal to spot prices in
inflationary periods, it would be unfair to sellers and they would
understandably stop making credit sales. After all, why should
they sell at a lower real price on credit, when they can get a
higher one on cash? If the answer is that the sellers should be
allowed to charge the prevailing price rather than. the one which
stood at the lime the possession of the commodity was
transferred to the buyer, then it will be a solution based on the
same broad principle which is applied in the case of indexation
Why should that principle be allowed in one area of the
economy (i.e. credit sales) and disregarded in others (financial
credit)?
The rationale for indention can also be viewed from another
angle. It has been pointed out in defence of the Islamic
proscription of interest that money represents the monetized
claim of its possessor to the property rights created by assets that
were obtained through work or transfer. Lending money is
virtually a transfer of this right, and all that can be claimed in
return is its equivalent and no more. Interest on money
represents unjustified creation of property rights because it
represents a right claimed outside the legitimate framework of
recognized property rights (Khan and Mirakhor 1987, 4). In case
borrowed money is returned on the basis of the principle of
indention, it represents neither the creation of any extra property
rights for the lender nor the expropriation of some of those
rights for him, as happens when some one lends interest-free
Loan in an inflationary period, in fact, it would be an effort to
enable the lender to receive back the equivalent of what he had
lent. Thus the proposal of extending index-based loans appears
to be the most acceptable to the spirit of the Islamic teachings of
economic justice.
On the question of how to implement the principle of indention1
the suggestion of Khan (M.A) is worth looking into. He has
proposed the floating of a new currency which can be used for
all contracts involving deferred payment by one party to another.
The value of that currency should be equal to a basket of
commodities and it should be readjusted daily on the basis of the
prevailing market price of (he commodities. Thus all borrowers
should borrow and likewise return in that currency whatever
may be its value in relation to the other currency. Likewise, all
agreements of salaries, wages, and contracts involving payments
over a period of time could also be agreed upon in that currency.
He also proposes that the currency should have a single buying
and selling rate to avoid speculation (Khan, M.A., op. cit., 6).
Despite the fact that the proposal seems quite promising, it
appears to have at least one potential flaw which might wreck
the whole idea: There appears to be no way suggested in the
proposal to prevent the proposed second currency - which would
assume the role of the store of value and, perhaps, legal tender
as well -- from driving the official market currency from the
economy. When two currencies are simultaneously allowed to
operate, the more stable one will be preferred by all in every
transaction and this would lead it to be virtually the commonly
used currency at the expense of the official one. Thus a reversal
of Gresham¶s Law is likely to be experienced: µgood money¶
will drive out µbad money¶. If any limitations on the supply of
that currency were to be imposed, such a move would restrict its
effectiveness in discharging the function for which it was
proposed. If it is suggested that such currency notes would only
be supplied to those who genuinely need them, then an
unnecessarily large task of distinguishing the genuine demands
from the non-genuine ones would have to be undertaken.
The proposal has, however, paved the way for further
discussions and proposal for introducing proper indexation to
protect asymmetry in the exchange of values in credit
arrangements at different points of time. It is surprising that the
writer who has presented the above proposal formally to
introduce indexation is himself a supporter of the ³arguments
against indexation, both from the shariah and economic point of
view.³ (ibid.). His subsequent attempt to introduce indexation is
enough to undermine that statement.
There are other proposals as well to index loans. The proposal of
Javed to give ³Purchase Value Loans´ in place of money loans
by linking the purchase value with certain basic commodities, is
one of them,´ Indeed, if the principle of fair treatment for both
panics is accepted, there should not be a dearth of proposals, It
should, however, be pointed out that even if the best of
indexation instruments are applied meticulously, there µwill stilt
be some variation in the actual value of the amounts borrowed
and returned. Complete and total parity in the values borrowed
and returned is neither possible nor should it be expected. What
needs to be done is to secure as much fairness for both panics as
is possible Allah does not expect from believers a behavior that
is beyond their ability. Qur¶an says: ³And give in full measure,
and weigh justly on the balance; no burden do We place on a
soul beyond capacity´ (Qur¶än, 6:152),
ft also needs to be clarified that indexation should be employed
only when money is borrowed either for business or
consumption purposes, It cannot be used in. case money is given
in trust for the purpose of safe-keeping alone, The reason is that
while in the former case the borrower has made use of the
current value of the money he obtained and should, therefore, be
obliged to return the same value, in the latter the funds have
remained unused, accruing no benefit to the possessor and, for
that reason, should not oblige him to return anything to the
owner except the face value of the funds entrusted to him.
The decision of Sindh High Court in Pakistan in the early 1990s
to allow repayment of a loan on the basis of indexation rather
than interest is a judicial recognition of the validity of indention
at the judicial level as an acceptable principle for repayments of
loans.



  
 
Another important clarification made by sunnah with regard to
interest is that the creditors are required to refrain not just from
accepting back any value more than the principal extended to the
debtor, but should avoid all other favours µn the form of gifts or
services which cannot be attributable to any other reason but the
fact that they are creditors.
For instance, Anas Ibn Malik reports that the prophet, peace be
upon him, said: ³When one of you grants a loan and the
borrower offers him a dish, he should not accept it; and if the
borrower often a ride on an animal, he should not ride, unless
the two of them have been previously accustomed to exchanging
such favours mutually´ (Al-Bayhaqi n.d., Vol. 5, 350).
Likewise, the same narrator reports that the prophet said this: ³If
a man extends a loan to someone he should not accept a gift.´3
It has been rightly pointed out that this prohibition is not
restricted to the few examples of favours mentioned in the above
narrations but extend to any kind of favours which a tender
receives from his borrower, even if it is apparently as
insignificant as taking advantage of the shade of his walls
(Saleh, op. cit. ,414).